In a May 2018 survey by The Pew Charitable Trusts, only 19% of small to midsize employers claimed to be “very familiar” with the expenses paid by their 401(k) plan, while 34% were “not at all familiar.” The remaining 47% said they were only “somewhat familiar.” These results are surprising when you consider employers have a fiduciary responsibility to pay only “reasonable” fees from 401(k) plan assets - and can be personally liable for restoring any excessive fees paid by participants.
So why do so many employers risk personal liability by being unfamiliar with their 401(k) fees? After all, following a decades-long groundswell in high-profile 401(k) fee lawsuits, shouldn’t most – if not all – employers understand their fiduciary responsibility to keep their 401(k) fees in check? My guess is human nature. I think most people are just wired to be apathetic about things they don’t understand – and the fees charged by some 401(k) providers can be unbelievably confusing.
Unfortunately, many 401(k) providers fuel employer apathy with confusing fees and services. The reason is simple – to get away with high fees. If you’re an employer, you must avoid this trap. To protect the interests of plan participants and avoid liability, you must be vigilant about your 401(k) fiduciary responsibilities. Vigilance is not difficult when you have a clear understanding of your responsibilities and how to meet them. Below is some basic guidance for doing that.
Paying reasonable 401(k) fees
Keeping 401(k) plan fees in check is one of your most important fiduciary responsibilities because paying excess fees today can dramatically reduce participant nest eggs decades from now due the power of compounding interest. Evaluating the reasonableness of 401(k) fees is a two-step process:
- Total all administration fees and investment expenses paid by your 401(k) plan into an “all-in” fee.
- Benchmark (compare) your all-in fee to industry averages or competing 401(k) providers.
The key to making this process simple is hiring a 401(k) provider with simple “direct” fees that are easy to total. You want to avoid 401(k) providers with “hidden” fees – like revenue sharing and variable annuity “wraps” – paid by plan investments. Unlike direct fees, the dollar amount of hidden fees doesn’t have to be disclosed in plan fee disclosures or reports, making them harder to total.
You also want to avoid asset-based administration fees to the extent possible. Except for asset custody, 401(k) administration services scale with employee headcount – not assets. That means your 401(k) administration fees should be based on headcount. Otherwise, your 401(k) administration fees can quickly outstretch your provider’s level of service.
Meeting investment-related fiduciary responsibilities
401(k) fiduciary responsibilities related to plan investments can seem particularly overwhelming, but they’re in fact the easiest to meet. They boil down to picking a fund lineup of “prudent” investments that gives plan participants access to a broad range of financial markets. A prudent investment is simply one that meets its investment objective for a reasonable fee.
Picking prudent funds is easy with index funds – which are designed to track a market benchmark (e.g., the S&P 500 index). This is true because comparable index funds (i.e., funds with the same market benchmark) from any of the largest providers – including Vanguard, Blackrock, Schwab, and Fidelity – offer similar returns and low fees. This uniformity makes it easy to avoid underperforming funds with excessive fees that increase their fiduciary liability. That’s in sharp contrast to comparable actively-managed funds – whose returns and fees can differ dramatically.
Meeting the diversification requirements of ERISA section 404(c) is the key to offering plan participants access to a broad range of financial markets. These requirements are not difficult to meet. A simple way to do it is by matching the funds used by the Federal government’s Thrift Savings Plan (TSP). While the funds used by the TSP are not available to the public, comparable low-cost funds are easily accessible.
If you’re not confident meeting your investment-related fiduciary responsibilities on your own, you should hire professional assistance. I recommend hiring an ERISA 3(38) “Investment Manager” or ERISA 3(21) “Investment Adviser." Unlike brokers or insurance agents, these financial advisors are obligated by law to give impartial (conflict-free) investment advice. The key difference between them is control. While a 3(38) advisor has full discretionary control over fund selection, a 3(21) advisor gives advice – which the employer can then accept or decline.
Meeting administration-related fiduciary requirements
I have good news and bad news about 401(k) fiduciary responsibilities related to plan administration. The bad news is they are numerous. They include:
- Keeping the governing plan document in compliance with applicable law.
- Operating the plan in accordance with its plan document, including:
- Letting employees participate based on the plan’s age and service eligibility requirements
- Allocating contributions to participant accounts based on the compensation definition used by the plan
- Paying out participant distributions, while forfeiting any non-vested portion of their account
- Administering participant loans (if applicable)
- Splitting participant accounts pursuant to a Qualified Domestic Relations Order (QDRO)
- Depositing participant contributions timely
- Meeting ERISA participant disclosure and government reporting requirements
- Completing any necessary plan testing and timely correcting any test failures
- Maintaining plan records in accordance with ERISA document retention rules
- Maintaining adequate ERISA fidelity bond coverage
The good news, however, is that a qualified 401(k) provider will do most of the heavy lifting in meeting these responsibilities. For the most part, you’ll just need to ensure that each responsibility has been met to properly monitor your 401(k) provider. To meet this monitoring responsibility, I recommend using a checklist.
Don't be exploited due to apathy!
401(k) fiduciary responsibilities are manageable once they’re understood. The problem is many employers don’t make the effort. That leaves them vulnerable to exploitation by opaque 401(k) providers with overpriced services. For that reason, I consider apathy the #1 source of 401(k) fiduciary liability today.